Financial Friction

In a controversial 1945 cartoon, Bugs Bunny pops up from burrowing underground. He realizes that he is in the Black Forest of Germany controlled by Nazis (note the release date). Bugs famously quips, "I knew I should've made a left turn at Albuquerque!"

A contemporary, seven minute viewing of "Herr Meets Hare" would require some viewers to look past Bugs fat shaming a rotund, lederhosen wearing Hermann Göring character, donning "blackface" to spoof Hitler and finally Bugs as Joseph Stalin in the climax scene. It added up to spicy political commentary at the end of World War II that was shown as propaganda to German POWs while Warner Bros prohibited it from being broadcast.

As investors are trying to decide how to get to their destination, potential detours and distractions abound.

This week the entirety of Germany's government bond issuance rallied to produce negative yields. Every Bund, as they are called, from 3 month to 30 year maturities now return less at maturity than what an investor would pay for one.

If this illogical financial condition existed in the 1940's, Germany may have won WWII. This negative rate phenomenon isn't unique to Germany. This is a pan-European head-scratcher. Swiss bank/broker UBS announced that they will start charging their wealthiest customers 3/4% for the privilege of leaving funds on deposit. Thanks to the European Central Banks policy actions, more than 1/3 of all bonds on the continent now have a negative yield.

To think that we were buying bonds at a discount to maturity value this time last summer. Big changes since then and I fear there are still more to come for "bond" investors. https://t.co/Alx3Vk9Msh

In the face of these negative rates from Europe washing up on our shores, our own central bank, The Federal Reserve, announced a 1/4% rate cut. This rate cut was anticipated by investors but Fed Chairman Jerome Powell stunned markets by obfuscating the Feds future intentions at his press conference with a quagmire of double speak. Will they cut again later this year or was this a one-and-done move?

A bevy of weak macroeconomic data released this week justified the Fed's near-term nervousness though. The economy is clearly slowing down. The question we've pointed out is a simple but profound observation: Is this weakness a natural by-product of the Feds rate increases last year or is the problem cyclical in nature and foreshadowing a deeper downturn or heaven forbid, a recession.

ISM Manufacturing Index and US Financial Conditions Index

Great chart suggesting that the #ISM#PMI Index could be below 50, and bounce back due to the drop in interest rates around the world https://t.co/njh8ngbzXp

To add fuel to the fires of uncertainty, Trump poured pressure on China by adding new tariffs on imported Chinese products. By doing so, Trump's trade shaming is designed to bring China back to the negotiation table instead of waiting until the Presidential election in 2 years. It remains to be seen if his strategy will be effective before the drag from tariffs stilts consumer activity.

Taken in totality these three signposts point to different potential outcomes. Investors need to think through this crazy set of events to assess what could impact their investment accounts. If Trump brings the trade battle with China to a successful conclusion, that would be viewed as pro-growth by markets. The Fed would walk back talk of further rate cuts and the bond market would have a migraine headache.

If this tariff impasse persists, US consumers, who are already signaling spending fatigue, will be shouldered with keeping the world out of recession. That's a really big "ask". With the never-ending, adversarial political tone in our country right now, Americans are being constantly cajoled in opposite directions. Don't let these distractions affect you. Stay diligent and clear headed even if you find yourself in the minority. That's the best advice to avoid ending up in the "Black Forest".